March 21, 2024

The running costs of a business are the amount of money that is regularly spent on things such as salaries, heating, lighting, and rent. Businesses have to keep track of operating costs as well as the costs associated with non-operating activities, such as interest expenses on a loan. Both costs are accounted for differently in a company’s books, allowing analysts to determine how costs are associated with revenue-generating activities and whether the business can be run more efficiently.Generally speaking, a company’s management will seek to maximize profits for the company. Because profits are determined both by the revenue that the company earns and the amount the company spends in order to operate, profit can be increased both by increasing revenue and by decreasing operating costs. Because cutting costs generally seems like an easier and more accessible way of increasing profits, managers will often be quick to choose this method.   What Are Operating Costs? Operating costs are associated with the maintenance and administration of a business on a day-to-day basis. Operating costs include direct costs of goods sold (COGS) and other operating expenses—often called selling, general, and administrative (SG&A)—which include rent, payroll, and other overhead costs, as well as raw materials and maintenance expenses. Operating costs exclude non-operating expenses related to financing, such as interest, investments, or foreign currency translation. The operating cost is deducted from revenue to arrive at operating income and is reflected on a company’s income statement. How to Calculate Operating Costs The following formula and steps can be used to calculate the operating cost of a business. You will find the information needed from the firm’s income statement that is used to report the financial performance for the accounting period. Operating cost=Cost of goods sold+Operating expensesOperating cost=Cost of goods sold+Operating expenses From a company’s income statement, take the total cost of goods sold, or COGS, which can also be called cost of sales. Find total operating expenses, which should be further down the income statement. Add total operating expenses and COGS to arrive at the total operating costs for the period. Types of Operating Costs While operating costs generally do not include capital outlays, they can include many components of operating expenses, such as: Accounting and legal fees Bank charges Sales and marketing costs Travel expenses  Entertainment costs Non-capitalized research and development expenses Office supply costs Rent Repair and maintenance costs Utility expenses Salary and wage expenses Operating costs will also include the cost of goods sold, which are the expenses directly tied to the production of goods and services. Some of the costs include: Direct material costs Direct labor Rent of the plant or production facility Benefits and wages for the production workers Repair costs of equipment  Utility costs and taxes of the production facilities A business’s operating costs are comprised of two components, fixed costs and variable costs, which differ in important ways. Fixed Costs A fixed cost is one that does not change with an increase or decrease in sales or productivity and must be paid regardless of the company’s activity or performance. For example, a manufacturing company must pay rent for factory space, regardless of how much it is producing or earning. While it can downsize and reduce the cost of its rent payments, it cannot eliminate these costs, and so they are considered to be fixed. Fixed costs generally include overhead costs, insurance, security, and equipment.Fixed costs can help in achieving economies of scale, as when many of a company’s costs are fixed, the company can make more profit per unit as it produces more units. In this system, fixed costs are spread out over the number of units produced, making production more efficient as production increases by reducing the average per-unit cost of production. Economies of scale can allow large companies to sell the same goods as smaller companies for lower prices. The economies of scale principle can be limited in that fixed costs generally need to increase with certain benchmarks in production growth. For example, a manufacturing company that increases its rate of production over a specified period will eventually reach a point where it needs to increase the size of its factory space in order to accommodate the increased production of its products. Variable Costs Variable costs, like the name implies, are comprised of costs that vary with production. Unlike fixed costs, variable costs increase as production increases and decrease as production decreases. Examples of variable costs include raw material costs and the cost of electricity. In order for a fast-food restaurant chain that sells french fries to increase its fry sales, for instance, it will need to increase its purchase orders of potatoes from its supplier. It’s sometimes possible for a company to achieve a volume discount or “price break” when purchasing supplies in bulk, wherein the seller agrees to slightly reduce the per-unit cost in exchange for the buyer’s agreement to regularly buy the supplies in large amounts. As a result, the agreement might diminish the correlation somewhat between an increase or decrease in production and an increase or decrease in the company’s operating costs.For example, the fast-food company may buy its potatoes at $0.50 per pound when it buys potatoes in amounts of less than 200 pounds. However, the potato supplier may offer the restaurant chain a price of $0.45 per pound when it buys potatoes in bulk amounts of 200 to 500 pounds. Volume discounts generally have a small impact on the correlation between production and variable costs, and the trend otherwise remains the same. Typically, companies with a high proportion of variable costs relative to fixed costs are considered to be less volatile, as their profits are more dependent on the success of their sales. In the same way, the profitability and risk for the same companies are also easier to gauge.  Semi-Variable Costs In addition to fixed and variable costs, it is also possible for a company’s operating costs to be considered semi-variable (or “semi-fixed”). These costs represent a mixture of fixed and variable components and can be thought of as existing between fixed costs and variable costs. Semi-variable costs vary in part with increases or decreases in production, like variable costs, but still exist when production is zero, like

A term sheet can be defined as a non-binding agreement that sets out the basic conditions for making an investment. It serves as a template for developing more detailed documents that are legally binding.Once an agreement has been reached between the parties concerned on the details set out in the term sheet, an agreement or contract will be drawn up that conforms to the details of the term sheet. What Is a Term Sheet? A term sheet is a nonbinding agreement that shows the basic terms and conditions of an investment. The term sheet serves as a template and basis for more detailed, legally binding documents. Once the parties involved reach an agreement on the details laid out in the term sheet, a binding agreement or contract that conforms to the term sheet details is drawn up. The term sheet should cover the significant aspects of a deal without detailing every minor contingency covered by a binding contract. The term sheet essentially lays the groundwork for ensuring that the parties involved in a business transaction agree on most major aspects. The term sheet reduces the likelihood of a misunderstanding or unnecessary dispute. Additionally, the term sheet ensures that expensive legal charges involved in drawing up a binding agreement or contract are not incurred prematurely.All term sheets contain information on the assets, initial purchase price including any contingencies that may affect the price, a timeframe for a response, and other salient information. Term sheets are most often associated with startups. Entrepreneurs find this document crucial for investors, often venture capitalists (VC), who may offer capital to fund startups. A term sheet used as part of a merger or attempted acquisition would typically contain information regarding the initial purchase price offer, the preferred payment method, and the assets included in the deal. The term sheet may also contain information regarding what, if anything, is excluded from the deal or any items that may be considered requirements by one or both parties. What’s Included in a Term Sheet The details to be included in a term sheet are highly dependent on the agreement at hand. What is included in a angel investment, early funding investment term sheet will be substantially different than what’s included in a commercial real estate development term sheet. Regarding an investment term sheet, commonly included details are: Nonbinding Terms. Neither party is legally obligated to abide by whatever is outlined on the term sheet. Company valuations, investment amounts, the percentage of stakes, and anti-dilutive provisions should be spelled out clearly. Voting rights. Startups seeking funding are usually at the mercy of VCs who want to maximize their investment return. This can result in the investor asking for and obtaining a disproportionate influence on the company’s direction. Liquidation preference. The term sheet should state how the proceeds of a sale will be distributed between the entrepreneur and the investors. Investor commitment. The term sheet should state how long the investor is required to remain vested. Regarding debt agreements, commonly included details are: Economic details. This includes the term, loan size, interest rate, and other financial matters common to debt. Risk mitigation preferences. The lender will often require specific conditions be met or specific information be provided on a recurring, timely manner. Extension rights. The borrower is often allowed to extend a loan, but the term sheet identifies the conditions and cost of extension. Due diligence at closing. As part of the term sheet, the lender may stipulate what they require when the loan agreement is drafted. This can include a list of requirements the borrower must prepare to be approved for the loan. Terms Found in a Term Sheet Investment Term Sheets Valuation (Pre-Money & Post-Money): Investors may want to see the pre-money valuation and post-money valuation before an official investment agreement is drafted. This valuation information should be based on what the valuation is before the investment is made as well as the value of the company including the new investment. Valuation Cap: The valuation cap is the value when convertible notes become eligible to covert into equity. Often an important negotiation point, this figure must be discussed early between the two parties to understand a fair point for the start-up to engage in a proper valuation and what protection is fair for the investor. Drag Along Clause: Investors may want guarantees that minority stakeholders will follow the guidance of majority stakeholders. A drag along clause requires that smaller investors lead larger investors in business decisions. Dividends: Investors may want upfront clarity on what net income distributions they will be entitled to. In addition to clarifying the dollar amounts, investors may want to know the timing (i.e. monthly, quarterly, or annual). Liquidation Preference: Investors may want to know the order in which owners are paid out in the event the company gets sold. This is important to investors as it reduces investment risk. Voting Rights; Investors may be interested in the say they have over the operations of the company. This may be an agreement on the number of votes the investor receives or any restrictions on matters in which they are not eligible to vote in. Pro-Rata Rights: Investors may want to better understand their rights for future rounds of investing. For example, depending on their current investment, they may be entitled to the right of first offer for an investment offering in the future. On the other hand, there may be penalties for investors that decide to not partake in future rounds of investing. No-Shop Agreement: Investors may want protection from other investors or other investment rounds. A no-shop agreement outlines the terms that restrict the company from taking investment money from other people for a specific period of time. Loan Term Sheet Loan Amount: Borrowers are obviously pursuing a specific amount of funds to borrow. This term may be a fixed dollar amount, subject to LTV metrics, or subject to DSCR and NOI calculations. Guaranty: Borrowers may be required to indicate what legal entity with more established credit may vouch for the debt and be held liable in the event that the direct company defaults. Interest Rate: Depending on the loan, these terms may widely